- Inflation has been an important driver for gold prices…
- …as well as the growth/inflation mix, real rates, the US dollar and safe haven demand
- A Democratic victory in November’s presidential elections…
- … will unlikely substantially change the US economic outlook
- Therefore, the growth/inflation mix and negative real yields will remain supportive for gold prices…
- …as well as a negative longer-term USD trend
- A Trump victory would be bullish for gold prices
In this Precious Metals Watch we investigate the possible impact of US elections on gold prices. We first provide an overview on how gold behaved during previous Presidencies and why. Then we focus on the upcoming US elections and what this could mean for gold prices.
How did the gold prices behave during previous Presidencies?
In general gold prices perform well in the following environments:
1. High US inflation
2. Financial crisis/uncertainty
3. Growth/inflation ratio below one
4. Decreasing or negative real yields
5. A lower US dollar
During the 1980’s and 1990’s, gold prices were very sensitive to changes in inflation (expectations). During the Presidencies of Ford, Carter, Reagan I, Reagan II, George Bush and Clinton I (see table below), consumer price inflation and gold prices moved in the same direction. This means that gold was seen as a hedge against inflation.
Since the Presidency of Clinton II the behaviour of gold prices has changed. More factors started to have an impact on gold prices such as growth/inflation mix, US economic growth compared out potential growth, US real rates and the US dollar. There are several reasons for this. First, during Clinton II, Fed monetary policy tightening quelled inflation fears and resulted in a considerable rise in US real yields. In addition, the US also had a fiscal surplus. This combination was negative for gold prices as well as the strong rally in the US dollar during the EM crisis. Despite several international crises during the Presidency of Clinton II (Asia, Brazil, Russia, LTCM, DotCom Bubble, Argentina) the US dollar outperformed gold.
Second, with inflation fears receding other factors have become more important. During the Presidencies of GW Bush I, GW Bush II and Obama I economic growth compared to potential (the US output gap) deteriorated. During these periods gold prices moved higher. What gave extra support to gold prices during GW Bush I and Obama I was the drop in real yields (official rates minus inflation) to negative territory.
Third, the introduction of ETFs in the gold market in 2003 has openend the gold market to a wider public. As a result, investors could take more easily positions in gold in anticipation of developments in financial markets. Gold prices have increasingly become more sensitive to the US dollar.
During the Presidency of Obama II, the output gap and US real yields improved. This together with a sharp rally in the US dollar resulted in a substantial drop in gold prices between 2013 and 2015. However, since the start of 2016 gold prices have rallied substantially (+24% versus the US dollar), because of a deterioration in US real yields and safe haven demand.
Possible scenarios for US government set-up (US analyst Maritza Cabezas, see also our US Watch Clinton vs Trump)
Our base case is that the Democrats will win the Presidential Elections. We think that a divided government will be the most likely outcome. We sketch two more likely scenarios and a low probability scenario. In the first two scenarios, Hillary Clinton is President and in the last Donald Trump is President. The variants in the first and second scenarios relate to the majority in the House and in the Senate.
I. Democrat President, Republican majority in House, Democratic majority in Senate
Under this constellation there will be policy gridlock. We expect that the economy will continue to grow at moderate levels and inflation will be moving towards the 2% target. Under this scenario debt/GDP will likely increase somewhat since the economy will not be able to reach the debt targets simply by growing.
II. Democrat President, Republican majority in House, Republican majority in Senate
Under this scenario (next to most likely), Republicans have the majority in the House and Senate. The potential for policy shifts is even more limited. We expect that economic growth will be weaker, but it is difficult to quantify the extent given vague policy details.
III. Republican President, Republican majority in House, Republican majority in Senate
This is a low probability scenario. We think that the proposals made by Mr. Trump will be toned down once he is in office. However, we think that the political risks resulting from uncertainty will be high under this scenario. The US economy would be more isolated and trade growth would be weaker than otherwise. Meanwhile foreign direct investment would likely be hurt. In this scenario economic growth would be softer. The debt/GDP ratio would increase significantly. The policy shifts proposed would cause significant uncertainty, which would also weigh on the economy.
Gold prices will remain supported if Democrats win…
Our forecast horizon does not cover the four years of the upcoming Presidency. Our forecasts cover up to the end of 2017. Our base scenario (with Democrats wining the elections) suggests that US economic growth will remain below trend, improving only slightly in 2017. Such a result will be supportive for gold prices for the following reasons
1. Inflation will likely be higher than growth
2. Real interest rates are forecast to remain negative (less negative though)
3. The longer-term US dollar has turned negative.
These are all supportive factors for gold prices. However, despite uncertainty on financial markets we don’t expect a new major crisis in the making. As a result, safe haven flows towards gold will likely be muted. All-in-all, gold prices will likely rise a moderate pace towards USD 1,650 per ounce over the coming years.
…while a Trump victory could result in even higher prices
If Trump were to become President (low probability in our view), gold prices will likely perform well, because we expect that his policies will be inward looking and will weaken the fundamentals of the US economy. In addition, his rhetoric and possibly policy actions could create domestic and international uncertainty at beast, and upheaval at worst.
Our US economist expects that economic growth would be weaker. This will likely result in a more substantial rise in gold prices towards USD 1,850 per ounce over the coming years.
However there is a major risk for gold prices
However, there is one major risk to gold prices. Gold prices will aggressively sell of if US real yields rise and growth/inflation mix and the output gap improve dramatically. This would be an environment in which the Fed hikes aggressively interest rates (more than inflation pick-up) because of strong (above trend) US growth. We think this is unlikely during our forecast horizon.